Economic growth during the winter dropped to a weak 3.1 percent, but now appears to be considerably stronger based on recent reports for trade, jobs, consumer spending and factory sales. The stronger pace should continue through this year, says Reed Research Group Economist Jim Haughey. The good news for distributors is that construction spending appeared to keep pace with the economy in the first quarter of this year, after falling behind in the second half of 2004.

In fact, construction market growth picked up from 3.0 percent to 3.2 percent, Haughey writes in the June issue of Construction Forecast Monthly. The faster construction market growth in the last quarter was entirely in home construction; real spending declined for non-residential buildings and expanded more slowly for engineering projects.

However, Haughey notes that economic growth is almost certain to be revised up to 3.5 percent to 4 percent based on late reports of a positive turnaround in the March trade balance. Looking ahead, construction activity is forecast to continue trailing overall economic growth through this winter and then grow faster than the economy for the rest of 2006.

Inflation-adjusted spending in the large residential market will decline slowly, with this weakness only partially offset by above-average gains in the smaller non-residential and heavy construction markets. Beyond next winter, the residential market will stabilize and the overall economic growth will begin to slow.

Haughey says the rapid expansion of the foreign sector of the U.S. economy changes both the mix of construction by type of product and the geographic location of construction. Residential construction is less impacted by a larger foreign sector than are non-residential projects. Within construction, the rapid growth of foreign trade has had the biggest negative impact on the workplace. Manufacturing plants and office buildings have been the two weakest sectors in construction markets for several years.

The expanded foreign sector has also pushed economic activity from the U.S. interior to the coasts, to be closer to foreign markets. As a result, the Northeast and Pacific coasts have had the strongest regional economies.

Two changes in mortgage financing in recent years have made the housing market much more volatile, with stronger booms in good times and deeper busts in bad times. For the last several years, and probably for several more years, homebuilders are enjoying "good times." But these good times have been at the cost of accepting the risk of a deeper bust in the housing market for some time ahead. Homeowners have taken on more of the interest-rate risk, and mortgage lenders have taken on more foreclosure risk.

In the United States today, low-income and poor-credit record households are scrambling to buy a home while they can, in a period of relatively cheap credit. They see home prices rising faster than their incomes. Mortgage lenders are only too willing to accommodate these buyers with premium interest rates and extra fees.

At the same time, households that already own a home are scrambling to buy a more expensive home. Mortgage lenders are meeting this demand with initially lower—but eventually higher—mortgage rates, or with deferred principal payments. In the high-cost housing areas on both coasts, many households—even those with incomes above the area median—can only buy a house by accepting more interest-rate risk in the form of variable rate mortgage or an interest-only mortgage.

Haughey writes that experience suggests that most households that take on more risk than traditionally considered prudent will not be foreclosed in the next inevitable period of declining employment and higher credit costs. But it only takes a small increase in the mortgage default rate to throw the housing market into turmoil by forcing a rise in mortgage rates to cover defaults.

Source: Reed Construction Forecast Monthly, Vol. 2, Issue 5. For subscription information, visit www.reedconstructionmonthly.com or call (800) 424-3996.